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ENGINEERING ECONOMY Fifth Edition
ENGINEERING ECONOMY
Fifth Edition
c M Graw Hill
c
M
Graw
Hill
Blank and Tarquin
Blank
and
Tarquin
ECONOMY Fifth Edition c M Graw Hill Blank and Tarquin I CHAPTER FOUNDATIONS OF ECONOMY ENGINEERING

I

CHAPTER

FOUNDATIONS OF

ECONOMY

ENGINEERING

and Tarquin I CHAPTER FOUNDATIONS OF ECONOMY ENGINEERING 1 Blank & Tarquin: 5th Edition. Ch. 1

1

Blank & Tarquin:

5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.

Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1. Foundations: Overview
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required for reproduction or display.
1.
Foundations:
Overview
1.
Questions
2.
Decision
Making
3.
Study Approach
4.
Interest
Rate
5.
Equivalence
6.
Simple
and Compound Interest
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
2
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1. Foundations: Overview
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required for reproduction or display.
1.
Foundations:
Overview
7.
Symbols
8.
Spreadsheet Functions
9.
Minimum Attractive
Rate
of Return
10. Cash Flows
11. Doubling
Time
12. Spreadsheets
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
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ENGINEERING ECONOMY Fifth Edition
ENGINEERING ECONOMY
Fifth Edition
c M Graw Hill
c
M
Graw
Hill
Blank and Tarquin
Blank
and
Tarquin
ECONOMY Fifth Edition c M Graw Hill Blank and Tarquin Section 1 I CHAPTER Economy is

Section 1

I

CHAPTER

Economy

is

Why Engineering

Important to Engineers (and

professionals)

other

Engineering Important to Engineers (and professionals) other 4 Blank & Tarquin: 5th Edition. Ch. 1 Authored

4

Blank & Tarquin:

5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.

Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.1 Importance
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Section 1.1 Importance
Engineers “Design”
Engineers must be concerned with the economic
aspects of designs
and perform
and
projects they
recommend
• Analysis
• Design
• Synthesis
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
5
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.1 Questions
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Section 1.1 Questions
Engineers must work
within the realm of
economics
and
justification of engineering
projects
Work
with limited funds (capital)
Capital
is
not
unlimited
rationed
Capital
does not belong to the firm
• Belongs
to the Owners of the firm
• Capital is not “free”…it has a “cost”
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
6
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Section 1.1
Definition
ENGINEERING ECONOMY IS INVOLVED
WITH THE
FORMULATION,
ESTIMATION,
AND
EVALUATION
OF
ECONOMIC
OUTCOMES
WHEN
ALTERNATIVES
TO
ACCOMPLISH A DEFINED
AVAILABLE.
PURPOSE
ARE
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
7
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Section 1.1
Definition
ENGINEERING
ECONOMY IS
INVOLVED
WITH THE
APPLICATION OF DEFINED
MATHEMATICAL
RELATIONSHIPS
THAT AID
IN
THE COMPARISON
OF
ECONOMIC
ALTERNATIVES
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
8
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.1 Questions
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Section 1.1 Questions
Knowledge
of Engineering Economy will
have a significant
personally.
impact
on
you,
• Make
proper economic
comparisons
In your profession
• Private
sector
• Public sector
In your personal
life
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
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ENGINEERING ECONOMY Fifth Edition
ENGINEERING ECONOMY
Fifth Edition
c M Graw Hill
c
M
Graw
Hill
Blank and Tarquin
Blank
and
Tarquin
ECONOMY Fifth Edition c M Graw Hill Blank and Tarquin Section 1.2 I CHAPTER Economy Role

Section 1.2

I

CHAPTER

Economy

Role of Engineering

Decision

Making

in

1.2 I CHAPTER Economy Role of Engineering Decision Making in 10 Blank & Tarquin: 5th Edition.

10

Blank & Tarquin:

5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.

Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.2 Role
Copyright © The McGraw-Hill Companies, Inc. Permission
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Section 1.2 Role of
Engineering Economy
Remember: People make decisions
“tools”
not
Engineering Economy is a set of tools that
aid in
decision
making –
but will not
make
the decision for you
Engineering economy is based mainly on
estimates of
future
events
– must deal with
the future and
risk and
uncertainty
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
11
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.2 Role
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Section 1.2 Role of
Engineering Economy
• The parameters within
an engineering
economy
problem
can and
will vary over
time
•Parameters
that can
vary
will dictate
a
numerical outcome
apply and
understand
•Sensitivity Analysis
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
12
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.2 Role
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Section 1.2
Role
of Engineering Economy
Sensitivity Analysis
plays a major
role
in
the assessment
of most,
if
not all,
engineering economy problems
The use
of spreadsheets is
now
common
and
students need to
master this
valuable
tool
as an analysis aid
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
13
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.2
Copyright © The McGraw-Hill Companies, Inc. Permission
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Section 1.2
Problem-Solving
Approach
1.
Understand
the Problem
2.
Collect all
relevant
data/information
3.
Define
the feasible alternatives
4.
Evaluate each alternative
5.
Select the
“best”
alternative
6.
Implement and
monitor
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
14
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.2
Copyright © The McGraw-Hill Companies, Inc. Permission
required for reproduction or display.
Section 1.2
Problem-Solving
Approach
1.
Understand
the Problem
2.
Collect
all relevant
data/information
3.
Define
the feasible
alternatives
4.
Evaluate each
alternative
5.
Select the “best” alternative
6.
Implement and monitor
Major Role of
Engineering
Economy
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
15
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.2
Copyright © The McGraw-Hill Companies, Inc. Permission
required for reproduction or display.
Section 1.2
Problem-Solving
Approach
1.
Understand
the Problem
2.
Collect
all relevant
data/information
3.
Define
the feasible
alternatives
4.
Evaluate each
alternative
5.
Select the “best” alternative
6.
Implement and monitor
One
of the
more
difficult tasks
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
16
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.2
Copyright © The McGraw-Hill Companies, Inc. Permission
required for reproduction or display.
Section 1.2
Problem-Solving
Approach
1.
Understand
the Problem
2.
Collect
all relevant
data/information
3.
Define
the feasible
alternatives
4.
Evaluate each
alternative
5.
Select the “best” alternative
6.
Implement and monitor
Where
the
major
tools
of Engr.
Economy are
applied
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
17
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.2
Copyright © The McGraw-Hill Companies, Inc. Permission
required for reproduction or display.
Section 1.2
Problem-Solving
Approach
1.
Understand
the Problem
2.
Collect
all relevant
data/information
3.
Define
the feasible
alternatives
4.
Evaluate each
alternative
5.
Select the “best” alternative
6.
Implement and monitor
Tools
Present Worth,
Future Worth
Annual
Worth, Rate of Return
Benefit/Cost, Payback,
Capitalized Cost, Value
Added
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
18
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.2 Time
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Section 1.2 Time Value of
Money
Time Value of
Money
Money
can
“make”
money if Invested
Centers around an
interest rate
The change
in the
amount of money over a
given time period is
called
the
time
value of
money;
by far,
the most important concept
in engineering
economy
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
19

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ENGINEERING ECONOMY Fifth Edition
ENGINEERING ECONOMY
Fifth Edition
c M Graw Hill
c
M
Graw
Hill
Blank and Tarquin
Blank
and
Tarquin
ECONOMY Fifth Edition c M Graw Hill Blank and Tarquin Section 1.3 I CHAPTER and Engineering

Section 1.3

I

CHAPTER

and

Engineering

Performing

Economy Study

1.3 I CHAPTER and Engineering Performing Economy Study 20 Blank & Tarquin: 5th Edition. Ch. 1

20

Blank & Tarquin:

5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.

Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.3 Performing
Copyright © The McGraw-Hill Companies, Inc. Permission
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Section 1.3 Performing a Study
To
have
a
problem, one must have
alternatives (two
or more ways
to solve
a
problem)
Alternative
ways to
solve a problem must
first
be
identified
• Estimate the
cash
flows for the
alternatives
Analyze
the cash flows
for
each
alternative
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
21
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.3 Alternatives
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Section
1.3 Alternatives
• To
analyze,
one must
have:
• Concept
of the time value
of $$
• An Interest
Rate
• Some measure of economic
worth
• Evaluate and
weigh
• Factor in noneconomic
parameters
• Select, implement, and
monitor
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
22
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.3 Needed
Copyright © The McGraw-Hill Companies, Inc. Permission
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Section 1.3
Needed Parameters
• First cost
(investment amounts)
• Estimates of
useful or project
life
• Estimated future cash flows
(revenues
and
expenses and
salvage
values)
• Interest rate
• Inflation and
tax effects
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
23
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.3 Cash
Copyright © The McGraw-Hill Companies, Inc. Permission
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Section 1.3 Cash Flows
Estimate flows of money
coming into the
firm
– revenues
salvage
values, etc.
(magnitude and
flows
timing) –
positive cash
Estimates of
investment costs, operating
costs,
taxes paid – negative
cash
flows
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
24
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.3 Alternatives
Copyright © The McGraw-Hill Companies, Inc. Permission
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Section 1.3 Alternatives
• Each problem will
have
at least
one
alternative
– DO NOTHING
May not
be free and
may have future
costs associated
Do not
overlook this
option!
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
25
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Section 1.3 Alternatives

Evaluate, Select and

Execute

Goal: Define,

Do Nothing
Do
Nothing
Alt. 1
Alt.
1

The

Which One do

we accept?

Question:

Nothing Alt. 1 The Which One do we accept? Question: Authored by: Dr. Don Smith, Texas

Authored by: Dr. Don Smith, Texas A&M University.

26

Blank & Tarquin: 5th Edition. Ch. 1

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Section 1.3 Mutually
Exclusive
Select One and
only one
from a set of
feasible alternatives
Once
an
alternative is
selected, the
remaining
that point.
alternatives are excluded at
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
27
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Copyright © The McGraw-Hill Companies, Inc. Permission

More

Alternatives

Section 1.3

Evaluate,

Select

and Execute

Goal: Define,

Do Nothing
Do
Nothing
Alt. 1
Alt.
1
Alt. j
Alt.
j

………

Which one

do we accept?

Authored by: Dr. Don Smith, Texas A&M University.

28

Blank & Tarquin: 5th Edition. Ch. 1

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Section 1.3 Default
Position
If all of
the
proposed
economically desirable
alternatives are not
then…
One
usually defaults to
the DO-NOTHING
alternative
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
29
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.3 Taxes
Copyright © The McGraw-Hill Companies, Inc. Permission
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Section
1.3 Taxes
• Taxes
represent
a
significant negative
cash flow to
the
for-profit
firm.
• A realistic economic analysis must assess
the impact
of taxes.
• Called and
analysis
AFTER-TAX
cash
flow
• Not considering
taxes is called a BEFORE-
TAX
Cash
Flow analysis.
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
30
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Section 1.3 Taxes
Copyright © The McGraw-Hill Companies, Inc. Permission
required for reproduction or display.
Section
1.3 Taxes
A Before-Tax cash
flow
analysis
(while not
as
accurate)
is often performed
as a
preliminary analysis.
A final, more
complete
analysis
should
be
performed
using an
After-Tax
analysis
• Both are valuable
analysis
approaches
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
31

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ENGINEERING ECONOMY Fifth Edition
ENGINEERING ECONOMY
Fifth Edition
c M Graw Hill
c
M
Graw
Hill
Blank and Tarquin
Blank
and
Tarquin
ECONOMY Fifth Edition c M Graw Hill Blank and Tarquin Section 1.4 I CHAPTER Rate of

Section 1.4

I

CHAPTER

Rate of

Interest Rate and

Return

Section 1.4 I CHAPTER Rate of Interest Rate and Return 32 Blank & Tarquin: 5th Edition.

32

Blank & Tarquin:

5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.

Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.4 Interest Rate
Copyright © The McGraw-Hill Companies, Inc.
Permission required for reproduction or display.
1.4 Interest Rate
INTEREST -
MANIFESTATION OF THE
TIME VALUE OF MONEY.
THE AMOUNT
PAID TO USE
MONEY.
INVESTMENT
INTEREST = VALUE NOW -
ORIGINAL
AMOUNT
LOAN
INTEREST = TOTAL OWED
NOW - ORIGINAL
AMOUNT
RENTAL FEE PAID
FOR
THE USE OF
SOMEONE
ELSES
MONEY…EXPRESSED
AS A %
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
33
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.4 Interest Rate
Copyright © The McGraw-Hill Companies, Inc.
Permission required for reproduction or display.
1.4 Interest Rate
INTEREST RATE -
INTEREST PER
TIME
UNIT
INTEREST PER
TIME
UNIT
INTEREST
RATE =
ORIGINAL
AMOUNT
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
34
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.4 Interest Rates
Copyright © The McGraw-Hill Companies, Inc. Permission
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1.4
Interest Rates and Returns
• Interest can
perspectives:
be viewed
from
two
1.
Lending
situation
• Investing situation
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
35
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.4 Interest -
Copyright © The McGraw-Hill Companies, Inc. Permission
required for reproduction or display.
1.4
Interest
-
Lending
You
someone
else's
borrow money (renting
money)
The lender
expects a return on the
money
lent
The return
is
measured
by
application of
an
interest
rate
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
36
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.4 Interest –
Copyright © The McGraw-Hill Companies, Inc. Permission
required for reproduction or display.
1.4
Interest
Lending
Example
1.3
Example 1.3
• You
borrow $10,000 for one
full year
Must pay
back
$10 700
,
at the
end of
one
year
• Interest Amount (I) = $10,700 - $10,000
• Interest Amount = $700
for
the year
• Interest rate
(i)
=
700/$10,000
= 7%/Yr
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
37
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.4 Interest Rate
Copyright © The McGraw-Hill Companies, Inc. Permission
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1.4
Interest
Rate - Notation
• For 1.3 the
interest
rate is
• Expressed as a per cent per year
• Notation
• I =
the interest
amount
is $
• i = the
interest
rate (%/interest
period)
N
=
No. of
interest
periods (1 for this
problem)
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
38
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.4 Interest –
Copyright © The McGraw-Hill Companies, Inc. Permission
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1.4
Interest
Borrowing (Ex 1.3)
The interest rate
(i)
is
7% per
year
The interest amount is $700
over
one year
The $700
represents the return to the
l en
d
er
f
or t hi s use
o
f hi s/
h
er
f
un d s
f
or
one
year
7% is the
borrower
interest
rate charged to the
7% is the
return
earned by the lender
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
39
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.4 Interest –
Copyright © The McGraw-Hill Companies, Inc. Permission
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1.4
Interest
Example 1.4
Borrow
$20,000 for 1 year at
9% interest
per
year
i
= 0.09 per year and
N = 1 Year
Pay
1 year
$20,000
+ (0.09)($20,000) at
end of
Interest (I) =
(0.09)($20,000)
=
$1,800
• Total
amt.
paid one
year
hence
•$20,000
+
$1,800 =
$21,800
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
40
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.4 Interest –
Copyright © The McGraw-Hill Companies, Inc. Permission
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1.4
Interest
Example 1.4
Note the following
Total Amount
Due one year
hence is
• ($20,000) +
0.09($20,000)
• =$20,000(1.09)
=
$21,800
• The (1.09)
factor accounts
for the repayment
of
the
$20,000 and the interest amount
This will
be one of the important
interest
factors to be seen
later
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
41
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.4 Interest –
Copyright © The McGraw-Hill Companies, Inc. Permission
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1.4
Interest
Investing
Perspective
Assume you invest
$20,000 for
one
year in a
venture that
will
return to you, 9% per year.
At the end of
one
year,
you
will
have:
•Original $20,000
back
•Plus……
•The 9% return
on $20,000
=
$1,800
We
say
that you earned 9%/year on the investment!
This is your RATE
of RETURN
on the investment
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
42
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.4 Inflation Effects
Copyright © The McGraw-Hill Companies, Inc. Permission
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1.4
Inflation Effects
A social-economic
occurrence
in which
there
is
more currency
competing for
constrained goods and
services
Where a country s currency becomes
worth
less over time,
thus
requiring more
of
the currency
to purchase the same
amount
of
goods or services in
a
time
period
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
43
Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.4 Inflation Rate(s)
Copyright © The McGraw-Hill Companies, Inc. Permission
required for reproduction or display.
1.4
Inflation
Rate(s)
• Inflation impacts:
Purchasing Power (reduces)
Operating
Costs (increases)
Rate
of Return on Investments
(reduces)
Specifically covered in
Chapter
14
Blank & Tarquin: 5th Edition. Ch. 1
Authored by: Dr. Don Smith, Texas A&M University.
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ENGINEERING ECONOMY Fifth Edition
ENGINEERING ECONOMY
Fifth Edition
c M Graw Hill
c
M
Graw
Hill
Blank and Tarquin
Blank
and
Tarquin
ECONOMY Fifth Edition c M Graw Hill Blank and Tarquin Section 1.5 I CHAPTER Equivalence 45

Section 1.5

I

CHAPTER

Equivalence

Hill Blank and Tarquin Section 1.5 I CHAPTER Equivalence 45 Blank & Tarquin: 5th Edition. Ch.

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1.5
EQUIVALENCE
• Example
You travel
at 68 miles
per hour
Equivalent to
110 kilometers
per hour
• Thus:
68 mph is
equivalent to
110 kph
• Using two
measuring scales
Miles
and Kilometers
Blank & Tarquin: 5th Edition. Ch. 1
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1.5
EQUIVALENCE
• Is “68” equal to
“110”?
• No, not
in terms
of absolute
numbers
• But they are “equivalent” in
terms of the
two
measuring scales
Miles
Kilometers
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1.5
ECONOMIC
EQUIVALENCE
• Economic
Equivalence
• Two
sums of
money at two different
points in time can
be
made economically
equivalent
if:
• We
consider an
interest
rate and,
No.
of time periods between the
two
sums
Equality in terms of
Economic
Value
Blank & Tarquin: 5th Edition. Ch. 1
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48
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1.5
Equivalence Illustrated
• Return to
Example 1.4
• Diagram the
loan (Cash Flow Diagram)
• The company’s perspective is shown
$20,000
is
received
here
T=0
t = 1 Yr
$21,800
paid
back here
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1.5
Equivalence Illustrated
$20,000
is
received here
T=0
t = 1 Yr
$21,800
paid
back here
$20,000 now is
economically equivalent to $21,800
one
year from now IF
the
interest rate is set to
equal
9%/year
Blank & Tarquin: 5th Edition. Ch. 1
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1.5
Equivalence Illustrated
$20,000 now is not
equal in
magnitude to
$21,800 1 year from now
But,
$20,000
now
is economically
equivalent
to $21,800 one
year
from
now
if
the interest rate is 9%
per year.
Another way
to put
it
is ……
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1.5
Equivalence Illustrated
If you
were told
that the
interest
rate is
9%
Read over
• Which
is worth more?
Example
1.6
• $20,000
now or
• $21,800
one year from now?
• The two sums are
economically
equivalent
but not
numerically
equal!
Blank & Tarquin: 5th Edition. Ch. 1
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52
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1.5
Equivalence Illustrated
To
have
economic
equivalence you
must
specify:
Read over
• Timing of
the cash flows
Example
1.6
• An
interest
rate (i% per interest period)
• Number of
interest periods (N
)
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1.6
Simple
and
Compound Interest
• Two
“types” of interest
calculations
• Simple
Interest
• Compound Interest
• Compound
Interest
worldwide
and applies
is more common
to most analysis
situations
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1.6
Simple
and
Compound Interest
• Simple Interest
• Calculated on the
principal
amount
only
• Easy (simple) to
calculate
• Simple Interest is:
(principal)(interest
rate)(time)
$I =
(P)(i)(n)
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ENGINEERING ECONOMY Fifth Edition
ENGINEERING ECONOMY
Fifth Edition
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c
M
Graw
Hill
Blank and Tarquin
Blank
and
Tarquin
ECONOMY Fifth Edition c M Graw Hill Blank and Tarquin Section 1.6 I CHAPTER Compound Simple

Section 1.6

I

CHAPTER

Compound

Simple and

Interest

Tarquin Section 1.6 I CHAPTER Compound Simple and Interest 56 Blank & Tarquin: 5th Edition. Ch.

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1.6
Simple
and
Compound Interest
• Example 1.7
• Borrow
$1,000 for 3 years
at 5%
per year
• Let “P” =
the principal sum
• i
=
the interest rate
(5%/year)
Let N =
number
of years
(3)
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1.6
Simple
and
Compound Interest
• Simple Interest
• DEFINITION
• I
= P(i)(N)
• For Ex. 1.7:
• I =
$1,000(0.05)(3)
=
$150.00
• Total
Interest
over
3
Years
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1.6
Simple
and
Compound Interest
• Year-by-Year Analysis:
Simple Interest
• Year 1
=
$1,000(0.05) =
$50.00
I 1
• Year 2
•I 2
=
$1,000(0.05)
= $50.00
• Year 3
=
$1,000(0.05) =
$50.00
I 3
Blank & Tarquin: 5th Edition. Ch. 1
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1.6
Accrued
Interest:
Year 1
• “Accrued” means “owed but
not yet paid”
• First Year:
P=$1,000
1
2
3
I
1 =$50.00
$50.00 interest accrues
but is
not
paid
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1.6
Accrued
Interest:
Year 2
• Year 2
P=$1,000
1
2
3
I
1 =$50.00
I
2 =$50.00
$50.00 interest accrues
but is
not
paid
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61
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1.6
End
of 3
Years
• $150 of
interest
has accrued
P=$1,000
1
2
3
I
1 =$50.00
I
2 =$50.00
I
=$50.00
3
Pay
back $1,000
The
unpaid
interest
did
not
+
$150 of
interest
earn
interest over the 3-year
period
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1.6
Simple
Interest: Summary
• In
a
multiperiod
situation with simple
interest:
The accrued interest does not earn
interest
during
the
succeeding time period.
Normall y, the total
sum borrowed (lent) is p aid
back
at the end of the agreed time
period PLUS
the accrued (owed
but
not
paid)
interest.
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1.6
Compound Interest
• Compound
Interest
is much
different
• Compound
means
to stop and
compute
• In
this application
, compounding
to
compute the interest owed
at the
means
end of
the period and
balance of the
then add
loan
it
to the
unpaid
Interest then “earns interest”
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1.6
Compound Interest
To COMPOUND –
stop and compute the
associated
interest and add it to
the
unpaid
balance.
Wh en n eres t i
i
t
s compoun d
e d
,
th e i
n
t eres t
th
a
t i s
accrued at
the
end
of a given time
period is added
in to
form a NEW principal
balance.
That new
balance then
earns
or is charged
interest in the succeeding time period
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1.6
Compound Interest:
Ex. 1.8
Assume:
• P = $1,000
• i = 5% per year
compounded annually (C.A.)
• N =
3 years
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Cash Flow

1.6

Compound Interest:

years, we

have:

3

For

compound interest,

P=$1,000

years:

$1,000 + 50.00 +

52.50

+

55.13 =

$1,157.63

Owe

at t

=

3

1

2

3

I 1

=$50.00

I

2 =$52.50

I

3 =$55.13

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1.6
Compound Interest:
Calculated
For
the
example:
P 0 = +$1,000
I 1 = $1,000(0.05) = $50.00
Owe P 1
=
$1,000
+
50 = $1,050 (but
we don’t
pay yet!)
New Principal sum at
end of t = 1: = $1,050.00
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1.6
Compound Interest:
t
= 2
Principal and
end
of year
1:
$1,050.00
I 1 = $1,050(0.05) = $52.50 (owed but not paid)
Add to the current unpaid balance yields:
• $1,050 + 52.50 = $1,102.50
• New unpaid
balance
or New
Principal Amount
Now,
go to
year 3…….
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1.6
Compound Interest:
t
= 3
New Principal sum:
$1,102.50
I 3 = $1102.50(0.05) = $55.125
= $55.13
Add to the beginning
of year principal yields:
• $1102.50 +
55.13
=
$1157.63
• This
is
the
loan payoff
at the end of 3 years
Note
how the interest amounts
were
added to
form
a
new principal
sum with
interest calculated
on
that new amount
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1.6
Example 1.9
Five plans are shown
that will pay off a
loan of
$5,000 over 5 years with
interest at 8%
per year.
Plan1. Simple Interest,
pay
all at
the
end
Plan 2.
Compound Interest, pay all
at the
end
Plan 3.
Simple interest,
pay interest at end
of
each
year.
Pay the principal
at the
end of N = 5
Plan 4.
Compound Interest
and
part of the
principal
each year (pay 20% of the Prin. Amt.)
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1.6
Example 1.9:
5 Plans
Plan 5.
Equal
Payments of the compound
interest
and principal
reduction over
5 years with end-of-
year
payments.
Note: The
following
tables will show the five
approaches.
For
now, do not try
to understand
how
all of the numbers are determined (that
will
come later!).
Focus on
the
methods and
how these
tables illustrate economic equivalence.
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Simple

Interest

1.6 Plan

1: @ 8%

Loan

Simple

Interest: Pay all at end on $5,000

1: @ 8% Loan • Simple Interest: Pay all at end on $5,000 Authored by: Dr.

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8%/yr

1.6 Plan

2: Compound Interest @

of 5 Years

Pay all at

the End

2: Compound Interest @ of 5 Years • Pay all at the End Authored by: Dr.

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Interest Pd. Annually

1.6 Plan

3: Simple

Principal Paid at the End (balloon Note)

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Compound Interest

1.6

Plan 4:

Paid back

annually

20%

of Principal

1.6 Plan 4: Paid back annually • 20% of Principal Authored by: Dr. Don Smith, Texas

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Repayment

Plan

1.6 Plan

5: Equal

and Part

Equal Annual Payments (Part Principal Interest

and Part Equal Annual Payments (Part Principal Interest • Authored by: Dr. Don Smith, Texas A&M

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1.6 Comparisons –
5
Plans
Plan 1 Simple interest = (original
principal)(0.08)
Plan 2 Compound interest = (total owed previous
year)(0.08)
Plan 3 Simple interest = (original
principal)(0.08)
Plan 4 Compound interest = (total owed previous
year)(0.08)
Plan 5 Compound interest = (total owed previous
year)(0.08)
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1.6 Analysis
Note that the
amounts of the
annual payments
are different
for each repayment
schedule and
that
the total
amounts repaid
for
most plans are
different, even
though
each repayment plan
requires exactly 5 years.
The difference in
the total amounts
repaid can be
explained (1) by
the
time value of money, (2) by
simple
or compound
interest, and (3) by
the
partial
repayment
of principal
prior to
year 5.
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Copyright © The McGraw-Hill Companies, Inc. Permission
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1.7 Terminology and
Symbols
Specific symbols
and
their
respective
definitions have
been developed
for
use
in
engineering
economy.
Symbols
tend to
be standard
in most
engineering
economy texts world-wide.
Mastery of
the
symbols and their respective
meanings
is
most important
in understanding
the
subsequent material!
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Copyright © The McGraw-Hill Companies, Inc. Permission
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1.7 Terminology and
Symbols
• P
=
value or amount
of money at a time
designated as
the
present or time 0.
• Also P is referred to as
,
present worth
(PW) ,
present
value
(PV), net present value (NPV),
discounted cash flow (DCF), and capitalized
cost
(CC); dollars
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ENGINEERING ECONOMY Fifth Edition
ENGINEERING ECONOMY
Fifth Edition
c M Graw Hill
c
M
Graw
Hill
Blank and Tarquin
Blank
and
Tarquin
ECONOMY Fifth Edition c M Graw Hill Blank and Tarquin Section 1.7 I CHAPTER Symbols Terminology

Section 1.7

I

CHAPTER

Symbols

Terminology and

and Tarquin Section 1.7 I CHAPTER Symbols Terminology and 82 Blank & Tarquin: 5th Edition. Ch.

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Copyright © The McGraw-Hill Companies, Inc. Permission
required for reproduction or display.
1.7 Terminology and
Symbols
• F
=
value or amount
of money
at some
future time.
• Also, F
is
called
future
worth
(FW)
and
future value
(FV); dollars
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1.7 Terminology and
Symbols
A = series
of consecutive,
equal,
end-of-period amounts of money.
•Also, A is called
the
annual
(AW)
and
equ va ent
i
l
un orm
if
annua l
worth
wort h
(
EUAW
);
dollars
per
year, dollars per month
n =
number of interest
periods; years,
months, days
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1.7 Terminology and
Symbols
i = interest rate or
rate of
return
per
time period;
month
percent
per year, percent per
t = time,
stated
in periods; years,
months, days,
etc
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1.7 P and F

P and F

represent

one-time

The symbols occurrences:

$F

Specifically:

t = n

n-1

0

1

2

n

$P

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1.7 P
and
F:
• It
should
be
clear
that
a
present value P
represents a single
sum
of money at some
time prior to a future value
F
•This
is an
important
basic point
to
remember
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1.7 Annual Amounts
• It
is
important to
note
that the
symbol A
always
represents a uniform amount (i.e.,
the
same amount each period)
that
exten s t h
d
roug h consecut ve
i
i
nterest
periods.
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1.7 Annual Amounts

for

annual amounts

Cash Flow diagram

might look like the

following:

$A

$A

$A

$A

$A

…………

might look like the following: $A $A $A $A $A ………… 3 N-1 n 0 1

3

N-1

n

0

1

2

A

=

equal, end of period

cash flow amounts

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Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.7 Interest Rate
Copyright © The McGraw-Hill Companies, Inc. Permission
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1.7 Interest Rate
– i% per
period
• The
interest
rate i is assumed
to
be a
compound
as “simple
rate,
unless specifically
stated
interest”
•The rate i
is expressed
in
percent
per
interest period;
year.
for
example,
12%
per
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Copyright © The McGraw-Hill Companies, Inc. Permission
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1.7 Terminology and
Symbols
For
many engineering
economy
problems:
• Involve
the dimension of time
• At
least
4
of the
symbols
{
P, F,
A, i%
and
n
}
At
least
3
of 4 are
either estimated
or
assumed
to be known with certainty.
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91
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Copyright © The McGraw-Hill Companies, Inc. Permission
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1.8
Computer
Solutions
Use of a spreadsheet
similar
to
Microsoft’s
analysis of
Excel is
fundamental to
the
engineering economy
problems.
Appendix
A of the
text presents
a
primer
on
spreadsheet use.
All
engineers are expected
by
training
to
know
how to manipulate data, macros,
and
the
various
built-in functions common
to
spreadsheets.
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1.8 Spreadsheets
Excel
supports (among many
others) six
built-in
functions
to assist in time value of
money
analysis
Master
each
on your own and
set up
a
variety
of the
homework problems (on
your own)
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ENGINEERING ECONOMY Fifth Edition
ENGINEERING ECONOMY
Fifth Edition
c M Graw Hill
c
M
Graw
Hill
Blank and Tarquin
Blank
and
Tarquin
ECONOMY Fifth Edition c M Graw Hill Blank and Tarquin Section 1.8 I CHAPTER to Solution

Section 1.8

I

CHAPTER

to Solution

by

Introduction

Computer

Section 1.8 I CHAPTER to Solution by Introduction Computer 94 Blank & Tarquin: 5th Edition. Ch.

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Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.8 Excel’s Financial
Copyright © The McGraw-Hill Companies, Inc. Permission
required for reproduction or display.
1.8 Excel’s Financial
Functions
• To
find
the
present value P: PV(i%,n,A,F)
• To
find
the
future value F: FV(i%,n,A,P)
• To
find
the
equal, periodic value A:
PMT(i%,n,P,F)
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1.8 Financial
Functions
-
Continued
To find the number of
periods
n:
NPER(i%,A,P,F)
To find the compound
interest rate i:
RATE(n,A,P,F)
To find the compound
interest rate i:
IRR(first_ cell:last_ cell)
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1.8 Financial
Functions
-
Continued
To find
the
present
value P of
any series:
NPV(i%,second_cell_last
cell) +
first cell
These built-in
Excel functions
support
a
wide variety of spreadsheet models that
are
useful
in
engineering economy
analysis.
Study Examples
1.10
and 1.11
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1.9 Minimum
Attractive Rate of
Return
• An investment is a commitment
of funds and
resources
in
a
project with the expectation of
earning a return
over and above
the
worth of the
resources that were
committed.
Economic Efficiency means that the returns
should exceed
the
inputs.
In the for-profit enterprise, economic
efficiencies greater than
100% are required!
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Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.9 The MARR
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1.9 The MARR
A firm’s financial
managers set a
minimum
interest
meet or
rate that that
exceed.
all accepted projects must
The rate,
once
established
by the firm is termed
the Minimum Attractive
Rate of Return (MARR).
• The MARR
is
expressed as a percent per year.
• Numerous
models exist to aid a firm’s financial
managers
in
estimating what this
rate
should be
in
a given time period.
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ENGINEERING ECONOMY
Fifth Edition
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ECONOMY Fifth Edition c M Graw Hill Blank and Tarquin Section 1.9 I CHAPTER Minimum Attractive

Section 1.9

I

CHAPTER

Minimum Attractive Rate of

Return

Section 1.9 I CHAPTER Minimum Attractive Rate of Return 100 Blank & Tarquin: 5th Edition. Ch.

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Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.9 MARR –
Copyright © The McGraw-Hill Companies, Inc. Permission
required for reproduction or display.
1.9 MARR
– Hurdle
Rate
In some circles, the MARR
Rate.
is
termed
the
Hurdle
• Capital
(investment funds)
is not free.
• It costs the firm money to raise capital
or to
use the owners of
the
firm’s
capital.
This cost
is often
expresses as
a % per year.
10
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Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.9 Cost of
Copyright © The McGraw-Hill Companies, Inc. Permission
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1.9 Cost of Capital: Personal
Example
• Assume you want to
purchase a new
computer.
• Assume you have a charge
card that
carries an
18% per year
interest
rate.
If you charge the purchase, YOUR cost
of
capital is the 18%
interest rate.
Very
high!
10
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1.9 Cost
to a
Firm
Firms raise capital
from the following sources:
Equity – using the owner’s funds (retained
earnings,
cash on hand–belongs to
the
owners)
Owners
expect a return
on their money
and
hence, there is a cost
to the firm
DEBT – the firm borrows
from outside the firm
and
pays an
interest rate on
the
borrowed
funds
10
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1.9 Costing
Capital
Financial
models
exist that will approximate
the firm’s weighted average
given time period.
cost of capital for
a
Once this “cost” is
approximated, then
new
projects
up for funding MUST return
at least
the
cost
of the funds used
in the project
PLUS
some
additional
percent
return.
The cost
is
expressed as a % per year just
like
an
interest rate.
10
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1.9 Setting
the
MARR: Safe Investment
• First, start
with a “safe” investment possibility
• A firm could always invest
in
a
short-term CD
paying around
4-5%
But
investors will
expect more that that!
The firm
should compute its current weighted
average
cost of capital (See
Chapter
10)
This cost will almost always exceed
a
“safe”
external investment rate!
10
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Copyright © The McGraw-Hill Companies, Inc. Permission
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1.9 Setting
the MARR
-
continued
• Assume the weighted average
(WACC)
is, say, 10.25%
(for
the
cost of capital
sake of
presentation)
• Certainly, the MARR must be
greater
firm’s cost of capital
in order to earn a
than the
“profit” or
“return”
that satisfies
the owners!
Thus,
some
additional
“buffer” must be
provided
to account for risk and uncertainty!
10
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Copyright © The McGraw-Hill Companies, Inc. Permission
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1.9 Setting
a
MARR
• Start with the WACC…
• Add a buffer
percent
(??
Varies from
firm to
firm)
This yields
an approximation
to a reasonable
MARR
This becomes the Hurdle
Rate that
all
prospective projects should earn in order to
be
considered for
funding.
10
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Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.9 Graphical
Copyright © The McGraw-Hill Companies, Inc. Permission
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1.9 Graphical Presentation:
MARR
RoR -
%
Acceptable range for new
projects
MARR -
%
Safe
Investment
WACC
- %
0%
10
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Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.9 Opportunity Forgone
Copyright © The McGraw-Hill Companies, Inc. Permission
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1.9 Opportunity
Forgone
• Assume a firm’s MARR
=
12%
• Two
projects, A and B
• A costs $400,000 and presents
an estimated
13% per year.
B cost $100,000 with an
estimated
return of
14.5%
10
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Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.9 Opportunity Forgone
Copyright © The McGraw-Hill Companies, Inc. Permission
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1.9 Opportunity
Forgone
What if the firm
has
a
budget
of, say,
$150,000?
• A cannot be
funded
not
sufficient
funds!
• B is funded and
earns
14.5%
return or
more
A is not funded,
OPPORTUNITY to
hence the firm
earn 13%
loses
the
This
often
happens!
11
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1.10
Cash Flow
Diagramming
Engineering Economy has developed
a
graphical technique
for presenting a
problem
dealing with
cash flows and
their timing.
• It’s called a CASH FLOW
DIAGRAM
• It’s similar
to a free-body diagram
in
statics
• First, some important TERMS .
.
.
.
11
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ENGINEERING ECONOMY Fifth Edition
ENGINEERING ECONOMY
Fifth Edition
c M Graw Hill
c
M
Graw
Hill
Blank and Tarquin
Blank
and
Tarquin
ECONOMY Fifth Edition c M Graw Hill Blank and Tarquin Section 1.10 I CHAPTER Their Estimation

Section 1.10

I

CHAPTER

Their Estimation

Cash

Flows:

and Diagramming

1.10 I CHAPTER Their Estimation Cash Flows: and Diagramming 112 Blank & Tarquin: 5th Edition. Ch.

112

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Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.10 Important TERMS
Copyright © The McGraw-Hill Companies, Inc. Permission
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1.10 Important TERMS
• CASH
INFLOWS
Money flowing INTO the firm from outside
Revenues, Savings,
Salvage
Values,
etc.
• CASH
OUTFLOWS
Disbursements
First costs of assets, labor, salaries,
taxes
paid,
utilities, rents, interest,
etc.
11
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Copyright © The McGraw-Hill Companies, Inc. Permission
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1.10 Cash
Flows
For
many
practical engineering
economy
problems the cash
flows
must be:
• Assumed known
with certainty
• Estimated
• A range of
possible realistic values provided
• Generated
from
an assumed
distribution and
simulated
11
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Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.10 Net Cash
Copyright © The McGraw-Hill Companies, Inc. Permission
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1.10 Net Cash
Flows
A NET CASH
FLOW is
Cash
Inflows
Cash
Outflows
• (for
a
given time period)
We normally assume
occur:
that all cash flows
At the
END of a given
time
period
End-of-Period Assumption
11
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Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.10 End-of-Period
Copyright © The McGraw-Hill Companies, Inc. Permission
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1.10 End-of-Period
Assumption
• END-OF-PERIOD Convention
ALL CASH FLOWS ARE ASSUMED
THE END OF AN
INTEREST PERIOD
TO OCCUR AT
THE
EVEN IF
MONEY FLOWS AT
TIMES WITHIN THE
INTEREST PERIOD.
THIS IS FOR SIMPLIFICATION
PURPOSES
11
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Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.10 The Cash
Copyright © The McGraw-Hill Companies, Inc. Permission
required for reproduction or display.
1.10 The Cash
Flow Diagram:
CFD
Extremely valuable analysis
tool
First step
in
the
solution process
Graphical
Representation
on a time
scale
Does not have to be drawn “to exact scale”
• But, should be
neat and properly
labeled
• Required on most in-class exams and part of
the grade for the problem
at hand
11
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Copyright © The McGraw-Hill Companies, Inc. Permission
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1.10 Example Cash
Flow
diagrams
Assume a 5-year
problem
The
basic
time line is shown below
“Now” is denoted
as t
=
0
11
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Copyright © The McGraw-Hill Companies, Inc. Permission
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1.10 Displaying
Cash Flows
A
sign convention
is applied
Positive cash flows are
normally
drawn
upward from the time
line
Negative cash flows are normally drawn
downward from
the
time line
11
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Copyright © The McGraw-Hill Companies, Inc. Permission
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1.10 Sample
CF
Diagram
Positive CF at t
= 1
Negative
CF’s at t =
2 & 3
12
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Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.10 Problem Perspectives
Copyright © The McGraw-Hill Companies, Inc. Permission
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1.10 Problem Perspectives
Before solving, one
must decide upon
the
perspective of the problem
Most problems will present two
perspectives
Assume
a
borrowing situation; for example:
• Perspective 1:
From the lender’s
view
• Perspective 2:
From the borrower’s view
• Impact upon
the
sing convention
12
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Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.10 Lending –
Copyright © The McGraw-Hill Companies, Inc. Permission
required for reproduction or display.
1.10 Lending
– Borrowing
Example
Assume
$5,000
is
borrowed
and payments are
$1,100
per
year.
Draw
the cash flow
diagram for
this
• First, whose
perspective
will
be used?
• Lender’s
or the Borrower’s
?
? ?
• Problem
will
“infer” or
you
must
decide….
12
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Copyright © The McGraw-Hill Companies, Inc. Permission
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1.10 Lending
– Borrowing
From the Lender’s Perspective
A = +$1,100/yr
0
1
2
3
4
5
-$5,000
12
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Copyright © The McGraw-Hill Companies, Inc. Permission
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1.10 Lending
-
Borrowing
From the Lender’s Perspective
P
=
+$5,000
0
1
2
3
4
5
A
= -$1,100/yr
12
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Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. 1.10 Example 1.17
Copyright © The McGraw-Hill Companies, Inc. Permission
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1.10 Example 1.17
A
father wants to
deposit
an unknown
lump-sum amount into
an investment
opportunity 2 years from
now that is
large
enough
to withdraw $4,000 per year
for state
university tuition
for 5 years starting
3
years
from
now.
If
the
rate of return
is estimated to
be 15.5%
per
year,
construct
the
cash flow
diagram.
12
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Copyright © The McGraw-Hill Companies, Inc. Permission
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1.10 Example 1.17
CF Diagram
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ENGINEERING ECONOMY Fifth Edition
ENGINEERING ECONOMY
Fifth Edition
c M Graw Hill
c
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Blank
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Tarquin
ECONOMY Fifth Edition c M Graw Hill Blank and Tarquin Section 1.11 I CHAPTER Estimating Rule

Section 1.11

I

CHAPTER

Estimating

Rule of 72:

Time

and

Interest

Doubling

Rate

Estimating Rule of 72: Time and Interest Doubling Rate 127 Blank & Tarquin: 5th Edition. Ch.

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1.11
Rule of
72
for Interest
A
common question
most
often
asked
by
investors
is:
How
long will it take
for my investment to
double in value?
Must
have
a known or assumed compound
interest
rate in advance
Assume a rate of
13%/year to
illustrate….
12
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Copyright © The McGraw-Hill Companies, Inc. Permission
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1.11
Rule of
72
for Interest
The Rule
of 72 states:
The approximate time for an
investment
to
double in value given the compound
interest
rate
is:
• Estimated time (n)
=
72/i
• For i
=
13%:
72/13
=
5.54 years
12
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Copyright © The McGraw-Hill Companies, Inc. Permission
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1.11
Rule of
72
for Interest
Likewise,
one can estimate
the
required
interest rate for an
over time as:
investment
to double
in
value
• i
= 72/n
approximate
• Assume we want an investment to
double in,
say,
3
years.
Estimate
i – rate
would be:
72/3
=
24%
13
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ENGINEERING ECONOMY Fifth Edition
ENGINEERING ECONOMY
Fifth Edition
c M Graw Hill
c
M
Graw
Hill
Blank and Tarquin
Blank
and
Tarquin
ECONOMY Fifth Edition c M Graw Hill Blank and Tarquin Section 1.12 I CHAPTER Application –

Section 1.12

I

CHAPTER

Application

– Simple

Spreadsheet

Interest,

and

and Compound Changing Cash

Estimates

Flow

Interest, and and Compound Changing Cash Estimates Flow 131 Blank & Tarquin: 5th Edition. Ch. 1

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1.12 Spreadsheet Applications
Section
1.12 introduces the concepts
associated with using a spreadsheet program
like Microsoft Excel.
To build and improve your knowledge
of
modeling
by using Excel,
you
must
build your
own models and experiment with the various
functions.
You
instructor will determine
the
extent and
depth of use of
Excel
for this course.
13
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Copyright © The McGraw-Hill Companies, Inc. Permission required for reproduction or display. Chapter Summary •
Copyright © The McGraw-Hill Companies, Inc. Permission
required for reproduction or display.
Chapter
Summary
Engineering Economy:
• Application of
economic
factors and
criteria
to evaluate
alternatives
considering the
time
value of
money
(interest
and time)
13
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ENGINEERING ECONOMY
Fifth Edition
c
M
Graw
Blank
and
Tarquin
Hill
CHAPTER
I
-
Summary
Summary
of
Important
Points
Blank & Tarquin:
5th Edition. Ch. 1 Authored by: Dr. Don Smith, Texas A&M University.
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Chapter
Summary
Engineering Economy Study
:
• Involves
modeling the
cash
flows
• Com p
utin g
s ecific
p
measures
of
economic worth
• Using
an
interest
rate(s)
• Over a specified
period of time
13
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Chapter
Summary
The
concept of equivalence helps
in
understanding
how
different sums of
money at
economic
different times
terms .
are equal
in
13
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Chapter
Summary
Simple and
Compound
Interest
• The differences between
simple interest
(based on
principal only) and compound
i t eres t
n
( b ase d on
pr nc i pa an d
i
l
i
n
t
eres t
upon
interest) have
been described
in
formulas,
tables, and graphs.
13
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Chapter
Summary
Compounding
of Interest
The power
of compounding is very
noticeable, especially over long periods of
ti me.
Notion
of computing
interest on interest
13
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Chapter
Summary
The
MARR
The MARR
is
a
reasonable rate
of return
established as
a
hurdle rate
to determine if an
a lt erna ti ve s econom ca
i
i
ll y v a
i
bl e.
The MARR
is
always higher than
a return
from a safe investment.
13
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Chapter
Summary
Attributes of
Cash Flows
• Difficulties
with their estimation.
• Difference
between estimated
and
actual
value.
• End-of-year convention for cash-flow
location.
14
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Chapter
Summary
Attributes of
Cash Flows
• Net cash
flow computation.
• Different perspectives
in
determining the
cash-flow
sign convention.
Construction
of a cash-flow diagram.
Introduction to
spreadsheet analysis
14
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Authored by: Dr. Don Smith, Texas A&M University.
1
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End
of
Chapter I Lecture Set
Blank & Tarquin:
5th
Edition. Ch. 1 Authored by: Dr.
Don Smith,
Texas A&M University.
142